The SEC’s Office of Investor Education and Advocacy is

INVESTOR BULLETIN

Investing in an IPO

The SEC’s Office of Investor Education and Advocacy is

issuing this Investor Bulletin to provide investors with

information they should consider when investing in the

shares of a new public company.

What is an IPO?

Historically, an initial public offering, or IPO, has

referred to the first time a company offers its shares of

capital stock to the general public. Under the federal

securities laws, a company may not lawfully offer or sell

shares unless the transaction has been registered with

the SEC or an exemption applies.

To register an offering, a company files a registration

statement with the SEC, typically using Form S-1.

Some offerings may involve other registration statement

forms. An important part of this registration statement

is the “prospectus” that will be used by the company to

solicit investors. The prospectus is the offering document

describing the company, the IPO terms and other

information that an investor may use when deciding

whether to invest. It is important to read the prospectus

because it provides information regarding the terms

of the securities being offered as well as disclosure

regarding the company’s business, financial condition,

management and other matters that are key to

deciding whether the offering is a good investment.

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Registration statements for IPOs are subject to review

by the SEC’s staff to monitor compliance with applicable

disclosure requirements. In such reviews, the staff

concentrates on disclosures that appear to conflict with

SEC rules or the applicable accounting standards and

on disclosure that appears to be materially deficient in

explanation or clarity. The staff ’s review often results in

revisions to the prospectus. However, the review process

is not a guarantee that a company’s disclosure is complete

or accurate, and the staff does not evaluate the merits

of any IPO or determine whether an investment is

appropriate for any investor. Rather, responsibility for

complete and accurate disclosure lies with the company

and others involved in the preparation of the company’s

registration statement and prospectus.

Once any staff comments have been addressed, the staff

will issue an order declaring the registration statement

effective, which means the company may proceed to

consummate its IPO. Although the staff will not

declare a registration statement effective if the staff

has reason to believe that the disclosure is incomplete

or inaccurate in any material respect, the SEC’s

declaration of effectiveness does not represent an

approval of the merits of the IPO or an indication

that the information disclosed is complete or accurate.

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The underwriters of the IPO typically will have obtained

“indications of interest” from prospective investors prior

to effectiveness and will use this information to

recommend a price for the shares to the issuer, who

ultimately determines the price of the IPO. Underwriters

are the investment banks that manage and sell the IPO

for the company.

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How do I learn about the company?

An IPO helps to establish a trading market for the

company’s shares. In conjunction with an IPO, a

company usually applies to list its shares on an

established stock exchange, such as the New York Stock

Exchange or NASDAQ. Any planned exchange listing

will typically be disclosed in the prospectus for the

IPO. The new public company will also be required on

a going-forward basis to disclose certain information to

the public, including its quarterly and annual financial

statements on Forms 10-Q and 10-K.

A company undertaking an IPO discloses required

information in the registration statement, typically on

Form S-1. Form S-1 and its amendments, which are

denoted as S-1/A, are filed with the SEC and publicly

available through the SEC’s EDGAR database at www.

sec.gov/edgar/searchedgar/webusers.htm. Comment

letters issued by the staff during the course of an IPO

filing review are also made available on EDGAR, but

they are not posted until at least 20 business days after

the registration statement is declared effective.

How do I invest in an IPO?

Most of a Form S-1 is comprised of the prospectus,

which contains important information about the

company. A new public company typically has no prior

reporting history, and the information that can inform

a decision to invest often can only be found in the

prospectus, although, if it has sold securities in reliance

on an exemption, the company may have filed one or

more notices on Form D.

An IPO gives the investing public an opportunity to

own and participate in the growth of a formerly private

company. By their nature, however, IPOs can be risky

and speculative investments.

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The other way, which is more common in the case

of individual investors, is to purchase the shares

when they are resold in the public market in the

days following the IPO. An investor could place an

order with his or her broker to purchase shares in

this manner.

There are two ways the general public can invest in

a new public company. First, if you are a client of

an underwriter involved in the IPO, you may be

offered the opportunity to directly participate in

the IPO. In this instance, you will be able to

purchase the shares at the offering price. It is often

the case that underwriters and dealers will distribute

most of the shares in the IPO to their institutional

and high net-worth clients, such as mutual funds,

hedge funds, pension funds, insurance companies

and high net-worth individuals. For the typical

investor, being able to directly buy in a popular

IPO is a unique opportunity.

Being well informed is critical in deciding whether

to invest. Therefore, it is important to review the

prospectus and ask questions when researching an

IPO. Whenever possible, verifying the information

you are given against independent sources is also

recommended. If you buy directly in an IPO you will

receive a copy of the prospectus before your broker

confirms your sale, but you can also read the prospectus

before then by reviewing the prospectus included in the

company’s most recent registration statement on

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EDGAR. When you read a prospectus, you should

check to make sure you are referring to the company’s

most recent filing, because the contents of the

prospectus may be revised during the course of the

registration process. In addition to reading the

prospectus, be sure to ask questions if the information

is not clear.

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Dilution illustrates the usually significant disparity

between the price that investors are paying for

shares in the company’s IPO to both (1) the book

value of such shares and (2) the average price paid

by existing shareholders that include founders,

officers and early investors.

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Selected Financial Data discloses certain key

financial and other data in a summarized column

format. The information and presentation can

highlight significant trends in the company’s

financial condition and results of operations.

Companies are generally required to disclose

selected financial data for the prior five years.

However, if the company is an “emerging growth

company” (as described in a section below), this

disclosure can be limited to the prior two years.

“Smaller reporting companies” (generally those

expected to have less than $75 million in publicly

held common stock following the IPO) are not

required to provide selected financial data.

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Management’s Discussion and Analysis gives

management an opportunity to discuss in narrative

form management’s perspective on the company’s

financial condition, changes in financial condition

and results of operations. This narrative section

should provide investors with information to help

them understand how and why the company’s

financial results have changed over the time period

covered by the financial statements and factors that

management thinks might affect the company’s

future financial condition or operating results.

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Business describes the company’s lines of business,

its principal products or services and their markets,

any significant suppliers and customers on whom

the company’s business depends, and its competitive

landscape and principal methods of competition,

among other matters. This section may also provide

After a company’s IPO registration statement has been

declared effective, the company will typically file a final

prospectus—usually identified as a 424B3 or 424B4

filing in the EDGAR database. The final prospectus

generally includes information related to the final

offering price that is not available at the time the

preliminary prospectus is distributed.

Highlighted below are some of the sections of an IPO

prospectus that an investor should consider. Of course,

other or additional sections may contain information

that is important to an investment decision in the

context of a particular IPO.

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Prospectus Summary briefly summarizes

information that is disclosed in greater detail

throughout the prospectus, including the company’s

business, strategy, plans for using the funds raised

in the IPO and financial condition, as well as the

terms of the IPO itself.

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Risk Factors identifies risks that the company’s

management feels could significantly impact the

company’s business, operations or performance,

or an investment in the securities being offered.

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Use of Proceeds specifies what the company

plans to do with the money it raises in the offering.

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Dividend Policy describes the company’s history

of paying, and possibly its plans to pay, dividends

to shareholders.

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information regarding the relative contribution

to the company’s financial results from different

significant lines of business or operations in foreign

countries. In addition, Legal Proceedings, which is

usually located at the end of Business, discloses the

significant litigation involving the company.

From the perspective of the company offering its shares

in the IPO, the higher the offering price, the more

capital the company can raise. The underwriters also

have an interest in a high price not only to meet the

company’s objectives, but also because their compensation

is typically a percentage of the offering price.

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Management offers biographical information

regarding the directors and executive officers of

the company.

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Financial Statements and Notes provides

standardized financial reports on the company’s

financial condition and performance. Emerging

growth companies and smaller reporting companies

are required to include two years of audited financial

statements in their IPO prospectuses (compared to

three years for other companies conducting IPOs).

In addition, immediately prior to the financial

statements is the auditor’s opinion that sets forth

the independent auditor’s opinion of the financial

statements it audited.

At the same time, the underwriters are responsible for

selling the IPO and will want a price that is attractive

to the client-investors to whom they will be selling.

Underpricing an IPO creates a discount for the initial

investors, increases the demand for the IPO and helps

the underwriters sell all of the available shares. Underpricing may also affect how much, if at all, the stock’s

price rises on its first trading day. If there is a large

increase, or “bump,” from the offering price during the

initial trading, the underwriter’s client-investors may be

satisfied because the value of their investment will have

increased. However, the company may be unsatisfied in

that case, as it might have been able to sell its shares at a

higher initial offering price and thereby raise more capital.

Informing these competing interests are valuation

analyses of the company’s business and the “order

book.” Valuation analyses, which can be conducted by

underwriters or potential investors, attempt to value a

company based on its revenues, customers, financial

results and other metrics. The “order book” is the

compilation of indications of interest that the underwriters have obtained from the client-investors they

solicited regarding the IPO. The order book lists how

many shares each client-investor would like to purchase

and at what price.

What else should I consider?

Following are some things to consider when making an

investment decision involving shares of a new public

company.

Offering price

The company and the underwriters make the decision

on where to set the offering price. The factors they will

consider in setting the price, as well as the terms of the

underwriting agreement between the company and the

underwriters, are discussed in the prospectus, usually

under the caption Underwriting or Plan of Distribution.

It is important to understand that the offering price is

determined by a mix of market conditions, analysis and

negotiation. Competing interests affect the determination

of the offering price.

All of the foregoing factor into the determination of

the offering price. Whether you have an opportunity

to participate directly in an IPO or are buying shares

in the open market, it is important to realize that the

offering price reflects a negotiated estimate as to the

value of the company. The offering price may bear

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little relationship to the trading price of the securities,

and it is not uncommon for the closing price of the

shares shortly after the IPO to be well above or below

the offering price.

Limited trading volume

The trading price of a new issue may be affected by

a limited supply of shares in the market immediately

following an IPO. The shares being traded on the first

day are generally only shares that were sold in the IPO.

All other outstanding shares, such as those held by

founders, early investors and employees that have not

been included in the IPO, may often not be sold in the

public market so soon after the IPO, either because

they are “restricted securities” under the federal securities

laws that can only be resold without registration under

certain circumstances, or because the existing shareholders have entered into a “lock-up agreement” in

which they agree not to sell their shares for a certain

period of time, typically 180 days.

In addition, purchasing shares in the market immediately

following an IPO can be risky. Underwriters can

support the trading price of the new issue in its first few

days of trading with certain trading activities, including

purchasing shares of the company. This is often done to

keep the trading price from falling too far below the

offering price. Once this support ends, the stock price

may decline significantly below the offering price.

Selling shareholders

Existing shareholders can sell their shares in the IPO if

their shares are included in and registered as part of the

offering. Most large IPOs include only new shares that

the company sells in order to raise capital. However, in

some cases, shares held by existing shareholders are

included in the IPO and the shareholders are called

“selling shareholders.” The proceeds from the sales by

selling shareholders do not go to the company and

instead go to the selling shareholders.

Moreover, underwriter policies that discourage

“flipping” also limit the number of shares sold in the

IPO that may trade on the public market in the first

few days or weeks of trading. “Flipping” is the term

used to describe the act of immediately reselling the

shares acquired in an IPO through the open market.

Underwriters may discourage flipping by refusing to

allocate IPO shares to customers who have flipped

shares in the past, but the practice of flipping, alone,

is not prohibited under the federal securities laws.

The cover page of the prospectus details how many

shares are being sold by selling shareholders, if any.

The company will also disclose the number of shares

each selling shareholder currently owns, plans to sell in

the offering, and will retain following the offering

under Principal and Selling Shareholders or a similarly

captioned section. Selling shareholders may include, in

addition to early investors seeking liquidity on their

investment, the company’s founders and management.

Companies must disclose any position, office or other

material relationship each selling shareholder has had

with the company within the past three years. It may

be worthwhile to discern the relationships the selling

shareholders have had with the company and what

proportion of their respective holdings is being sold.

These restrictions, lock-up arrangements and underwriter flipping policies all serve to limit the number

of shares that trade in the public market immediately

following an IPO. The resulting limited trading

volume, particularly in the case of a highly soughtafter IPO, can operate to drive the trading price of

an issue steeply up because of the limited supply to

meet the high demand.

Market overhang

The number of shares that are outstanding but cannot

be traded at the time of the IPO is sometimes referred

to as the “market overhang.” The share price after an

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Investors in new public companies can determine

whether a company maintains a dual-class common stock

structure and the rights they will have as shareholders

by reviewing the first page of the prospectus as well as

the section entitled Description of Capital Stock.

IPO may decline over time as shares that were previously

restricted become available for sale. In addition, when

lock-up agreements expire, the share price may decline

significantly if a large number of shares become available

for sale all at once. Early investors and shareholders in

a company often view an IPO as an exit strategy—a

way to realize a profit on their investment by being

able to sell shares to the public. The lock-up expirations

give these early investors the opportunity to sell their

shares to the extent they weren’t able to do so as

selling shareholders in the IPO.

Stage of the company

An IPO is a significant milestone for a company,

and high-profile IPOs frequently include companies

that have exhibited recent tremendous growth and

development. However, companies at different stages

of development engage in IPOs for various reasons.

Often, a company is seeking to access the capital markets

in order to fund future growth and expansion. In other

instances, a large and mature business may be returning

to the public market after a successful reorganization

under bankruptcy. It is important to keep in mind

that an IPO does not always represent an opportunity

to invest at an early stage with a fast-growing company.

An investor can discover the extent of a company’s

market overhang in the IPO prospectus. A company

must discuss the shares that it has agreed to register for

sale or that will be available for sale without registration

following the IPO. This disclosure can typically be found

under Shares Eligible for Future Sale or a similar caption.

Dual-class common stock

An increasing number of companies engaging in IPOs

have created separate classes of common stock with one

class having greater voting power than the class being

sold in the IPO. This dual-class common stock structure

is often used by companies that are family-controlled

or will continue to be led by their founders, with the

“super-voting” common stock held by the founders or

controlling family. With this structure, the holder of

the super-voting common stock has a much greater

percentage of the voting rights in the company than his

or her equity stake would otherwise provide and can

control the company without owning a majority of its

shares. Generally, the super-voting common stock

converts to the lesser-voting class of common stock

when sold by its initial holder. While many successful

companies maintain a dual-class common stock

structure, investors should be aware that such a

structure may make it more difficult, if not impossible,

for public shareholders to exert any influence or

control over corporate matters.

Emerging growth companies

One thing to keep in mind before investing in an IPO

is that many disclosure and other requirements that

now apply to public companies are phased in over time

for what are called “emerging growth companies.”

Emerging growth companies generally have less than $1

billion in revenue. A company will remain an emerging

growth company for up to five years after becoming a

public company, unless its revenue exceeds $1 billion or

it exceeds certain other thresholds.

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Emerging growth companies may elect to have the

same extended periods of compliance that may be

available for private companies to implement any

new or revised accounting standards. This means

that other public companies may have to implement

new or revised accounting standards before emerging

growth companies do. Emerging growth companies

will have to disclose whether or not they are electing

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to take advantage of the extended compliance

periods. When you compare an emerging growth

company’s financial statements to those of other

companies, you should keep this potential difference

in mind.

balanced research report on a company and their

desire to facilitate a successful offering on behalf

of the company, which is their investment banking

client or potential client.

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Emerging growth companies are not required to

have their auditors annually assess their internal

controls over financial reporting. Other public

companies that are not emerging growth companies

have up to two years after their IPO before they are

required to have their auditors assess their internal

controls, and smaller reporting companies are

exempt from this requirement. After the IPO,

management of emerging growth companies will

have to assess the effectiveness of internal controls,

like other public companies, but a separate auditor’s

assessment of such controls is not required.

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Emerging growth companies do not have to disclose

as much about executive compensation as other

public companies.

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Emerging growth companies do not have to

conduct shareholder advisory votes on executive

compensation arrangements, such as “say-on-pay”

and “say-on-golden parachutes” votes.

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Brokers and dealers, including underwriters who

are participating in an emerging growth company’s

IPO, are allowed to provide research reports regarding

emerging growth companies prior to, during and

after the IPO registration process. These research

reports may not present all the information

required in a prospectus filed with the SEC and are

not subject to the stricter liability standards for a

prospectus. Investors should keep in mind that

brokers and dealers participating in the offering

may face a conflict of interest between their

obligation to provide their research clients with a

A research report can provide useful information,

but as a general matter, you should never rely solely

on a research report. You should also do your own

research—such as reading the prospectus—to

determine whether a particular investment is

appropriate in light of your own financial

circumstances.

Additional Information

For information on how to search for company

documents, such as prospectuses and registration

statements, in the SEC’s EDGAR database, visit

investor.gov/researching-managing-investments/

researching-investments/using-edgar-researchingpublic-companies and www.sec.gov/investor/pubs/

edgarguide.htm.

For our investor alert about Pre-IPO Investment

Scams, visit www.investor.gov/news-alerts/investoralerts/investor-alert-pre-ipo-investment-scamsupdated.

For information about Analyzing Analyst Recommendations, visit www.sec.gov/investor/pubs/

analysts.htm.

For information about being able to directly

participate in an IPO, visit www.sec.gov/answers/

ipodiff.htm and www.sec.gov/answers/ipoelig.htm.

For more information about IPO lock-up agreements,

visit www.sec.gov/answers/lockup.htm.

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For more information about IPO and post-IPO

pricing disparities, visit www.sec.gov/answers/

ipopricing.htm.

For our investor bulletin about Say-on-Pay and

Golden Parachute Votes, visit www.investor.gov/

news-alerts/investor-bulletins/say-pay-goldenparachute-votes.

For our investor bulletin on How to Read a 10-K,

which summarizes information that companies

provide in annual reports on Form 10-K, visit

www.investor.gov/news-alerts/investor-bulletins/

how-read-10-k.

For additional educational information for investors,

see the SEC’s Office of Investor Education and

Advocacy’s website for investors, www.investor.gov.

The Office of Investor Education and Advocacy has

provided this information as a service to investors.

It is neither a legal interpretation nor a statement of

SEC policy. If you have questions concerning the

meaning or application of a particular law or rule,

please consult with an attorney who specializes in

securities law.

SEC Pub. No. 133 (2/13)